Wall Street Journal — Dawne Hickton has seen the future—and it is old people.
After building a business largely on selling titanium to the U.S. defense industry, Ms. Hickton is turning her sights to health care.
RTI International Metals Inc., of which Ms. Hickton is chief executive, last year paid $182 million to buy a medical-device business, gaining access to the market for spinal implants and other products for the nation’s growing numbers of senior citizens. “That’s a future for us—the elderly population,” Ms. Hickton says. “That’s a growing market. We don’t know what the defense market is going to do.”
Over the past three years, she says, Pittsburgh-based RTI’s defense work has been cut in half, falling to 20% of the company’s revenue from 40%.
Faced with more defense cuts on the horizon, RTI is part of a broader shift by defense companies, large and small, looking for ways to contend with lost business. Some of them are diversifying. Others are shedding unprofitable segments, closing plants or laying off workers. Many are looking to increase sales on the international market.
“What we’re about to go through happens once every 20 to 30 years in the industry, and it requires different thinking and behavior to succeed,” says Erich Fischer, a partner at consulting firm Booz & Co.
The challenge stems from the Obama administration’s attempts to move from a post-Sept. 11, 2001, “war on terrorism” mind-set to a post-Afghanistan-war period. That shifting worldview has led to an agreement with Congress to cut $487 billion from the defense budget over the next 10 years.
Even if U.S. lawmakers avert $500 billion in additional cuts over the next decade that were put on hold by this week’s fiscal-cliff agreement, the Pentagon is expected to face additional reductions in any deal to cope with a fragile economy and massive debt. Meanwhile, the U.S. is preparing to end major combat operations in Afghanistan, wrapping up more than a decade of ground operations in South Asia and the Mideast.
Those factors are generating anxiety among defense companies. “Nothing changes table manners faster than a smaller pie,” a top industry executive says. “And we are all competing for less.”
The last big decline in military spending came at the end of the Cold War in the 1990s, when the U.S. closed 350 military installations. Defense companies responded with a series of mergers that shrank the number of major contractors working with the Pentagon.
In 2011 the top five U.S. defense contractors secured more than a quarter of all military spending. The Obama administration is opposed to moves that would decrease competition further, so analysts don’t expect any consolidation at the top of the food chain.
But European Aeronautic Defence & Space Co.’s unsuccessful attempt last year to purchase Britain’s BAE Systems PLC suggests that at least one merger among the next tier of Pentagon contractors could be on deck within a few years. BAE, in particular, holds an especially coveted New Hampshire unit that makes equipment for military surveillance.
As U.S. military dollars shrink, large defense contractors are laying off workers, closing plants and consolidating operations.
Boeing Co., the country’s No. 2 defense contractor, is closing operations in Kansas and California. Boeing said in November that it would cut 30% of its management jobs and consolidate units in its defense, space and security business. The Chicago-based company has cut $2 billion in costs since 2010 and plans to slice another $1.6 billion through the consolidation, says spokesman Todd Blecher.
Smaller defense contractors also are looking to streamline and to focus on new areas, such as cybersecurity or unmanned vehicles. L-3 Communications Holdings Inc., a top-10 U.S. defense contractor, spun off its consulting and government-services work in July as it moved to reinvent itself.
The New York company paid $130 million in August to buy a British aircraft training-and-simulation business. In February L-3 paid $210 million for a unit of Washington-based Danaher Corp. that makes sophisticated electrical units for U.S. Navy submarines.
L-3 Chief Executive Michael Strianese says defense companies have to be careful as they move into new ventures. “I don’t think it’s a good strategy for defense companies to wander too far outside their core areas,” he says. “We’ve all done that at some point in our lives, and it usually doesn’t end well.”
“There’s not a silver bullet out there that will solve everybody’s problem,” Mr. Strianese says.
To make up for dwindling opportunities in the U.S., companies also are looking to increase sales overseas, with emerging markets in Brazil and India appearing especially fruitful. As the U.S. shifts more strategic resources to Asia, arms sales to U.S. allies in the region are also expected to rise.
To help facilitate that effort, the Obama administration has moved to ease export controls to help companies sell arms abroad. In November L-3 secured a $23 million deal to help train some Iraqi military pilots.
Overseas sales to developing nations by U.S. defense contractors quadrupled in 2011 to a record $56.3 billion, according to the Congressional Research Service, as the administration approved deals with Saudi Arabia, the United Arab Emirates and other countries.
American companies have been lobbying Washington to ease export controls further. They recently secured support from Congress to expand satellite sales abroad, something that could give a boost to Boeing, among others.
Meanwhile, though, U.S. defense contractors are facing new competition in the U.S. market from foreign companies, including EADS and Switzerland’s Pilatus Aircraft Ltd.
They also face more pressure from nontraditional rivals, such as consulting firm Accenture PLC and computer makers Apple Inc. and Dell Inc. Such nontraditional defense contractors account for about 40% of major new post-Cold War hardware programs and services sold to the Pentagon, says Booz’s Mr. Fischer.
Old-line defense contractors will have to become more nimble to compete with the new rivals, according to Booz. “Defense companies need faster development and fielding cycles to remain relevant for large portions of their core markets,” Mr. Fischer says.
By Dion Nissenbaum
Posted on January 3, 2013
Wall Street Journal | Defense Firms Seek Alternatives as U.S. Cuts Military Spending